Let’s imagine that you own a gas station.
A week ago, the supply truck filled the underground tanks at your station at a wholesale cost of $3.30 per gallon.
Today, as you opened the station for business, you learned that the wholesale cost had dropped to $3. You look across the street and see a supply truck filling up the tanks at the competition, and a new posted retail price that’s 15 cents less per gallon than your price.
You quickly recognize you have one of two options: You can meet or beat the competition’s price to sell your gas quickly and restock while wholesale prices are low. Or, you can stick to your guns and sell your gas at a 15-cents-per-gallon premium to cover your wholesale costs and maintain your retail margin.
Which option would you choose?
For my money, the first option is the wisest course. No doubt, the decision would cause short-term pain, given you’ve paid a higher wholesale price for your gas than the competition. But the decision would help you more quickly align your wholesale costs and retail prices to the current market — and ensure ongoing price competitiveness and relevance for potential customers at your station.
I’ve shared this example with dealers in the past and most agree that it’s best for the station owner to bite the bullet and get rid of the higher-cost gasoline. Ironically, however, many of these dealers won’t make the same choice when it comes to used vehicles at their dealerships.
When wholesale prices for used vehicles decline, these dealers often hang on to their higher-cost inventory and retail prices in the hope that the market will come around to their way of thinking. Inevitably, they end up fighting a losing battle that creates wholesale losses and diminished profitability in their used vehicle departments.
This dynamic repeated itself in the summer of 2012 as wholesale values for used vehicles were largely on the decline since spring. This was the first time in roughly two years that dealers had seen significant drops in wholesale values. In that time, the biggest challenge had been finding the right used cars and buying them “on the money,” given consistently high wholesale prices.
Around this time, I had many calls from dealers asking for guidance on how to adjust to the new market reality and achieve their goals for return on investment (ROI) and profitability in their used vehicle departments. I often share the following three recommendations to help dealers recognize the commonality they share with the gas station owner who’s sitting on a supply of a higher-cost gasoline:
1. Take the lump and move on.
I recognize that dealers are often eternal optimists. “The market will come back!” is part of the rationale they offer for holding onto used vehicles that have lost value. While I understand why dealers think this way, I’m always quick to point out that they’re just guessing about the future. What if they’re wrong and the market doesn’t come back? How will you purchase fresh cars if your money is tied up in aging, overpriced cars on your lot? The key is to play the hand the market deals rather than wishing for a different set of cards. This might mean less front-end gross profit on some cars. But dealers can still achieve gross profit for reconditioning and F&I sales as they sell out of the cars the market made problematic. In other words, the lump is more like a bruise.
2. Trust the traction of inventory turn.
In the past two years, many Velocity® dealers eliminated wholesale losses in their used vehicle departments. They rarely, if ever, load up the truck with cars destined for the auction. Their secret? These dealers focused on turning their used vehicle inventory at retail more quickly. They acquired the right cars, set the right retail asking prices and turned metal into money again and again. This turn-‘em-quick mindset provides Velocity® dealers greater traction when the wholesale market slides — they’ve reduced their exposure to declines in vehicle values, and they’re able to quickly adapt to new market conditions.
3. Tally the takeaway lessons.
I often tell my sons, “You’ll make mistakes in life. Just do your best to avoid making the same ones twice.” As wholesale values decline, dealers will inevitably find the exit strategy on some cars more difficult than others. I encourage dealers to take careful note of these vehicles and the reasons they’re more troublesome: Did you pay too much to acquire them at auction or trade-in? Is your inventory too deep with a particular make or model? Did the combination of your reconditioning costs and changing market conditions kill your ROI and profitability potential? The answers to these questions often prove valuable to manage future market volatility, which will inevitably occur.